Rising put option sales reflect market fears as supply of shares exceed demand

With uncertainty mounting, investors are seeking to hedge their portfolios, but the soaring cost of put options has left traders anxious, potentially edging the market into oversold territory.

In volatile markets, options traders often lean toward selling more calls than puts. Selling puts in a downtrending market can lead to steep losses, so experienced traders, sensing potential declines, adopt a cautious stance by favouring call options.

When markets trend lower, call options become more affordable, attracting traders who anticipate a reversal. These investors buy call options in the hope that a market bounce will boost the option's premium (price), allowing them to profit from a potential upswing.

When such a scenario plays out, the put call ratio (PCR) declines. Sentiment becomes particularly bearish if the PCR falls sharply. From 1.07 on 1 November, the Nifty PCR has fallen to 0.73 on 12 November, according to data analytics company IndiaCharts. The Nifty PCR veers in a range of 0.7-1.3, with anything below 0.7 being oversold and above 1.3 being overbought.

Over this period the Nifty has fallen 1.7% from 24,304.35 to 23,883.45.

The 24,300 put contract, expiring on November 28, saw its value surge from ₹360 per share on 1 November to ₹476 by 12 November as market sentiment turned bearish. Meanwhile, the 24,300 call, expiring on the same date, plummeted from ₹449 per share to just ₹106, giving call sellers substantial gains on the premium received.

Also read: Index options trading swells to record high in Oct amid heightened uncertainty

The comparison shows why traders sold more calls than puts. The put seller would be sitting on a notional loss of ₹116 ( ₹476 current premium minus ₹360 premium received from call buyer). The call seller would have secured a profit of ₹343 from the premium initially paid by the call buyer, as the 24,300 call price dropped from ₹449 per share to ₹106 amid the market's decline.

That is what drives down the PCR when sentiment turns negative. But a very low PCR also indicates markets are oversold.

"The current PCR shows that markets are nearing the oversold zone and a reversal could be in order, but the market keeps falling , which reflects the heightened bearishness," said Rohit Srivastava , founder of IndiaCharts.

"Indicators are favouring a bounce but we aren't getting one, suggesting that we could keep correcting for now."

Why are markets falling?

Markets are on a downturn as the supply of shares in both primary and secondary markets exceeds demand, driven largely by selling from foreign institutional investors (FIIs). Inflows from mutual funds are expected to fall short of this supply by an estimated two-and-a-half times in the second half of FY25, adding pressure to share prices.

"The accelerating pace of equity supply is the key reason domestic equity markets are again developing a vulnerability to the volatility in foreign flows," explained Ashish Gupta, chief investment officer, Axis Mutual Fund.

The IPO pipeline for the second half of FY25 is nearly three times that of the first half, with 91 companies aiming to raise a combined $17 billion through listings, according to Gupta.

Another 70 listed companies have taken board approvals in recent weeks to raise an aggregate $16 billion of equity through qualified institutional placements (QIPs). Secondary stake sales from promoters and private equity is also only likely to grow larger, given the expiring lock-ins and elevated trading multiples in the market.

Also read: Interested in options? Here’s how you can use VIX to time your trades.

"Assuming secondary sales (by promoters and PE investors) at $22 billion in second half stays similar to what we have seen in first half, the total supply will rise to $55 billion in the second half of the year or about 2.5x the estimated inflows into mutual funds. This could result in equity supply overwhelming domestic fund flows and market direction being subject to the vagaries of foreign flows," he added.

FIIs have offloaded Indian equities worth ₹26,935 crore so far this month, according to National Securities Depository Limited (NSDLO) and provisional BSE data. In contrast, domestic institutional investors (DIIs) have net purchased shares worth ₹17,895 crore as of November 12.

Why are FIIs selling?

Several factors explain the FII sell-off. For one, Indian corporate earnings have been lacklustre amid high valuations.

For instance, the net profit of 1,982 companies that reported Q2FY25 earnings grew just 2.5% year-on-year to ₹3.56 trillion. In contrast, the same quarter last year saw 38% growth to ₹3.47 trillion, underscoring a sharp slowdown in earnings momentum.

Also read: Persistent FII selling to keep markets on edge

Another major reason is rising bond yields in the US. Fiscal deficit concerns are growing as President-elect Donald Trump has pledged corporate and personal tax cuts, coupled with tariff hikes, which could fuel inflation.

Despite three cumulative Fed rate cuts totalling 75 basis points since 18 September, the US 10-year yield has surged by 66 basis points to 4.37% as of Tuesday.

This anomaly – bond yields rising despite rate cuts – has made US treasuries, widely considered the safest asset globally, more attractive, prompting FIIs to reallocate funds from emerging markets such as India to US government bonds.